Troubled waters

Australia has been a strong performer in the past decades, with its GDP expanding by +2.9% on average in the 2000s and +2.6% on average in the 2010s. A strong post-pandemic recovery and favorable terms of trade have positioned Australia more favorably in the cyclical aspect compared to most advanced economies. However, household consumption slowed since 2022-2024, with headwinds arising from higher interest rates and the ongoing cost-of-living pressures, especially on housing, continuing to impact demand. Additionally, a sharp slowdown in export growth indicates that the external sector contributed almost neutrally in 2024. As more than 30% of Australian exports go to China, this phenomenon could become even stronger as trade tensions between China and the US escalate. Likewise, China’s growth is converging to a slower path than before, which will also affect Australian exports and growth. Growth slowed down from +3.9% in 2022 to +2.0% in 2023 and likely +1.2% in 2024. However, real incomes are expected to increase in 2025, supporting household consumption and eventually helping GDP growth to pick up. This is why we expect Australia’s growth to reach +2.1% in 2025 and 2026. Australia is on a path to a mild recovery. Over the coming years, a more sustainable balance between supply and demand across the economy, including in labor and product markets, is expected to support the return to low and stable inflation as growth in domestic activity returns to trend.

Although the fiscal deficit increased significantly because of measures implemented during the Covid-19 crisis, increased tax revenues and the expiry of Covid-era support programs led to a steep consolidation of the fiscal balance in 2022. In 2023, high commodity prices and lower unemployment allowed the government to register a narrow deficit of -0.9% of GDP. Despite those two years of fiscal balance improvements, sources of fiscal pressure, such as falling global prices for Australia’s commodity exports, an aging population, climate change and the country’s heavy reliance on tax revenues, led the fiscal deficit to widen to an estimated -1.7% in 2024 and to -2.0% in 2025. This deficit could also respond to rising defense costs, healthcare and welfare spending.

The RBA’s rapid monetary policy tightening in 2022-2023 (+425bps to the policy rate), managed to slow down inflation substantially. The RBA has been on hold since the end of 2023, waiting for clear signs that inflation is headed back towards the 2-3% target range. We forecast inflation to retreat to 2.8% in 2025 and 2.6% in 2026 (after an estimated 3.3% in 2024), allowing the RBA to cut its policy rate by at least -100bps in 2025-2026.

Australia’s business environment is well-positioned in our assessment of 185 economies. The World Bank’s annual Worldwide Governance Indicators surveys suggest that the regulatory and legal frameworks are business-friendly and the level of corruption is low. Likewise, the Heritage Foundation’s 2024 annual Index of Economic Freedom surveys have put Australia 13th out of 184 economies in recent years and 4th in the Asia-Pacific region, reflecting very strong scores with regards to property rights, judicial effectiveness, government integrity, business freedom, trade freedom, investment freedom and financial freedom. However, Australia scores less favorably regarding the tax burden, attributed to a 45% income tax rate and a 28.7% of GDP tax burden. In our proprietary Environment Sustainability Index 2024, Australia ranks 42nd out of 210 economies, up from 54th place in 2023. Underperformance is mainly visible in renewable electricity output, recycling rate and CO2 emissions per GDP.

After the general election in May 2022, the Labour party, led by prime minister Anthony Albanese, is likely to remain in power until the end of its term in 2025, partly thanks to its support from the Greens and the independents. Those parties had benefited from an increased number of votes during the 2022 elections, reflecting the electorate’s concern with climate change and corruption. Of particular interest heading into this election year is the Labor government's proposed campaign finance laws. The amendments include limits on donations and campaign spending as well as a lowering of the disclosure threshold to AUD1000 from its current threshold of AUD16,9000. The intent of these reforms is to limit big money’s influence on Australian politics. At the election to be held by May 2025, the Labour Party will be defending a narrow majority and runs the risk of emerging with a minority government.